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The Pamida retail chain sought higher profits by modernizing a distribution center. Too bad it left old software in place.

Dan Nicklen found himself sitting quietly through a series of crisis meetings. The vice president of information systems at retail-chain operator Pamida was unable to offer an answer to serious inventory shortages at the Midwestern chain, even though the company's distribution management software was part of the problem.

The expansion of Pamida's distribution center in Lebanon, Ind., was supposed to usher in a new era of "full-service" warehousing and improve the Pamida retail stores' ability to stock their shelves. Instead, a logjam at the warehouse caused earnings shortfalls in the first nine months of 2001and Pamida's corporate parent, ShopKo, saw its overall revenue decline 1% to $2.4 billion, producing a loss of $6.7 million.

The distribution center was overhauled, but the software used to run it had not been upgraded in advance. Instead, an outdated and inflexible warehouse software package helped cause the meltdown at Omaha-based Pamida, which generated $806 million in sales last year. Those same limitations meant that Nicklen and his team weren't spearheading the fix.

"We didn't have a lot to do with the turnaround," says Nicklen. "We tried to lay as low as possible."

He credits vice president of logistics Nancy Brooks with leading the effort that turned the center from one labeled "dysfunctional" by ShopKo chief executive William Podany in mid-2001, to what the company says became a fully functional one by year's end. ShopKo says the 2001 holiday season went smoothly, although costs of the center remained high. For the nine holiday weeks ended Jan. 5, 2002, Pamida sales were down 4.2% over the previous year. In an apparent vote of confidence for the Indiana center, ShopKo announced in January it will close a smaller warehouse in Missouri and consolidate distribution at its Indiana and Nebraska centers.

The problems, which surfaced in late 2000 at Pamida's Indiana distribution center, resulted in estimated lost sales of $5 million, with sales at the 107 stores served by the Lebanon center lagging other stores in the 229-site chain by 5%. This led in part to the filing of several class-action lawsuits by shareholders, which claim that management failed to disclose the severity of the distribution center problems. Through a ShopKo spokesman, ShopKo and Pamida declined comment for this story, other than a single interview with Nicklen.

The company denies allegations by the shareholders that it kept its stock price up by remaining quiet until November 2000, when it first acknowledged the impact of inventory problems on its gross margins. The margins have been falling from 26.3 cents on each dollar of sales when the problems emerged, to 20.8 cents in its most recent quarter.

Securities analyst Eric Beder of Ladenburg Thalmann in New York is cautiously optimistic the distribution center has been fixed, but admits he has been burned by the slow turnaround.

"I thought the turn would have been in the third quarter, but it was a mess," he says. "The whole design led to a breakdown."

Beder has a "buy" recommendation on the stock, in large part because it is so cheap as a multiple of earnings. ShopKo has other issues to deal with, including tough competition for its flagship general merchandise stores from the likes of Wal-Mart and Target, as well as some $850 million in debt.

ShopKo bought Pamida in 1999, not long after Podany, a longtime department-store executive who had been ShopKo's chief operating officer, took the top job. The small-town chain was meant to goose growth for the Green Bay, Wis., merchandiser as its ShopKo brand faced more competition in larger markets. Pamida had nearly 150 stores selling in small towns such as Crete, Neb., and Belle Fourche, S.D. ShopKo quickly added 49 stores with the acquisition in May 2000 of a chain called P.M. Place, in Missouri, Iowa, Kansas and Illinois.

As the major retail presence in most of its small markets, Pamida depends on the convenience of a high in-stock rate, rather than the lowest prices, to keep customers coming back to its midsized stores. "Pamida's information technology strategy is aimed at providing the customer with ... merchandise which is always available as advertised," says a company filing with the SEC. But when the distribution system built around outmoded software choked, the chain couldn't get promoted items on the shelves at many stores, even as the product sat inside the Indiana warehouse.

The Lebanon Distribution Center Project, begun in the first quarter of 2000, was part of a plan to streamline Pamida's inventory management by going from five warehouses to three. The Indiana center was expanded from 200,000 square feet to 418,000 square feet. It also was converted from a flow-through facility (in which goods come in from suppliers and go directly back out to stores) to a full-service distribution center that maintained inventory and shipped out goods as needed by the stores.

Unfortunately, Pamida's outdated warehouse management software from Catalyst International was inadequate for the task. The older version made it hard to lay out and run a full-service center in the most logical and efficient ways. "We are several versions behind where we need to be," says Nicklen. "It is not real flexible, so the processes at the distribution center had to conform to the system." Podany has been quoted as blaming the distribution center problems in part on "some design flaws and incorrect data input ... or incomplete data."

"We have made significant enhancements in the configurability of the product, things we couldn't do when Pamida was putting in its system," says Dan Trew, vice-president of product strategy at Milwaukee-based Catalyst. "Things like set-up wizards, configuration wizards, and simulation tools that allow users to reflect changes in the warehouse without actually making the change. Now we have advance planning tools to avoid bottlenecks." Catalyst International is a well-regarded, $34 million a year vendor but not a market leader, says Steve Banker, director of supply chain research at ARC Advisory Group.

Newer versions of warehouse management software are flexible enough to decide on optimal use of storage space or forklift-driver routing within a particular site, says Ron Hounsell, vice president for software solutions at consultant Tom Zosel Associates in Long Grove, Ill. "You tend to have to recode with older systems to configure them to your needs, instead of toggling features on and off in a newer one," says Hounsell. Up-to-date packages, for example, give warehouse operators flexibility by letting them see two or three locations ahead when filling an order, rather than telling them where to get just the next item on the list.

Replacing the software had not been a priority because it was working well enough under the old distribution system, says Nicklen, and, crucially, it was Y2K compliant while other systems at Pamida were not and therefore got the attention. To some degree, then, the Pamida difficulties were an unintended consequence of doing the right thing in preparation for a disaster that never happened.

"The Catalyst system was plugging away," says Nicklen.

Instead of replacing or updating its warehouse software, Pamida focused on a three-year program to replace all of its mainframe systems and software, such as implementing new merchandising software from Retek Information Systems. "Our resources were stretched thinunder our previous owners we were always underfunded," says Nicklen. Pamida was owned by an investment group and by its employees prior to being acquired by ShopKo.

When the crisis hit and shelves went unfilled heading into Christmas 2000, Pamida was locked in to its existing Catalyst software, leaving Nicklen little to contribute beyond audit reports at the daily meetings held in the tense fall months. Instead, logistics VP Nancy Brooks steered the solution. "There was no time to get a new system; that would have caused a new problem as we were going into the holiday season," says Nicklen. "We will be into 2003 before we look at getting current on our [warehouse management] software."

Ironically, effective technology has been a Podany priority. ShopKo has made substantial investments in IT, and Podany was quoted in 1999 as crediting those investments with the chain's 98% in-stock rate for promoted items. He also spoke of plans to improve supply chain operations by using sophisticated technology such as collaborative planning, forecasting and replenishment (CPFR) software, which allows companies to work more closely with their suppliers to manage inventory.

Beyond any software shortcomings, the planning process for the Lebanon center was also muddied by management turnover, including the departure of Pamida CEO Steve Fishman in July, 1999 and the arrival of COO Robert Doughton the following spring. There was also the task of melding with the newly acquired P.M. Place chain, based in Bethany, Mo.

"One thing I am not comfortable about is that the senior management of ShopKo is still trying to figure out how to run these smaller stores, two years after the acquisition," says securities analyst J. David Cumberland of Robert W. Baird in Milwaukee.

Pamida retains its own management in Omaha, distinct from the ShopKo brass in Green Bay, a practice Podany says he will continue.

Podany himself has been part of the management changes, stepping down as chairman in May 2001 while remaining CEO. He was replaced by former Musicland chairman and chief executive, Jack Eugster.

In spring 2001, ShopKo ended up taking direct control of the distribution center project, along with transportation and human resources management.

"The turnover was a problem because management was not as well informed as they needed to be about what was going on, and we got less than we needed from the vendors brought in to help us because our management was not in place," says Nicklen.

Pamida also lacked the kind of knowledge management needed to replicate its own successful distribution center in Omaha. "Transferring knowledge is a big deal with older systems," says Hounsell. "It is harder to import and export data."

Says Nicklen, "We couldn't model off of Omaha because it works on people knowledge, not processes. We have tried to formalize the process, but that takes time."

Taking the time to capture internal knowledge and then manage it, as well as implementing a more recent version of its warehouse management software in 2000, not 2002, might have better served Pamida and its customers, says Nicklen. And, possibly, ShopKo investors.

As it is, the company is still awaiting the kind of aggressive growth Podany was trying to get from Pamida. For now, ShopKo would probably settle for the kind of profit margins it enjoyed before the distribution center project began.

Ed Cone has worked as a contributing editor at Wired, a staff writer at Forbes, a senior writer for Ziff Davis with Baseline and Interactive Week, and as a freelancer based in Paris and then North Carolina for a wide variety of magazines and papers including the International Herald Tribune, Texas Monthly, and Playboy. He writes an opinion column in his hometown paper, the Greensboro News & Record, and publishes the semi-popular EdCone.com weblog. He lives in North Carolina with his wife, Lisa, two kids, and a dog.